Waiting for the Dough

The CFO of a start-up maker of medical devices is prepared for years of intense capital-raising efforts and tough cost-allocation decisions on the way to profitability.David McCann, CFO.com | USOctober 16, 2009

Sometimes, attaining success is a matter of patience. That's especially true for executives at start-up companies not likely to feature a black bottom line for years.

At Sanuwave, a company that develops innovative, noninvasive medical devices that use shock waves to treat a variety of ailments, there's more to do during those years than make and market products. The first priority is overcoming the biggest risk facing the company: that the Food and Drug Administration will not approve the devices. Toward that end, clinical trials must be conducted for every "indication" — medical lingo for a condition that makes a particular treatment advisable — that the company thinks the devices will be used to treat.

For Sanuwave's CFO, Barry Jenkins, that precarious situation requires a steadfast focus on two areas: raising the capital needed to fund the trials and develop the products and, just as important, allocating the available capital in the best way among the many clinical and R&D projects proceeding simultaneously.

That's not to say that preparing the company's financials isn't important, particularly since Sanuwave went public at the end of September. Jenkins says the company became aware of investors who were interested in it but preferred the idea of owning public stock — which they could sell at some point — over making private investments. But to avoid spending the millions of dollars needed to execute an initial public offering, Sanuwave went public by merging with an existing, inactive shell company.

It was the latest step in the evolving identity of Sanuwave, created in 2005 when two venture-capital firms bought the orthopedic division of HealthTronics — a company best known for its lithotriptors, which use shock waves to blast kidney stones into small particles. The division the firms bought was at that time producing shock-wave devices to treat plantar fasciitis (a painful heel condition) and tennis elbow.

Jenkins recently spoke with CFO.com about his overlapping priorities and the business realities facing an immature publicly held company. An edited version of the interview follows.

How have you been funded so far?Our two primary investors, Prides Capital and Nightwatch Capital, were already invested in HealthTronics and liked the [orthopedic division] assets. After the division was purchased, they continued to fund us through early this year — over $32 million in total.

The venture funds are still involved, but like many funds, their available resources have been under pressure. So we knew it was critical for us to spread our investment base, which was why we decided to go public with the reverse merger. There were a number of private accredited investors we had talked to that would be interested in us if we were a public company. It gives them a known exit versus being locked into a private company and not knowing what their exit strategy could be down the road. We raised almost $2 million from these investors. It was somewhat of a "friends and family" round.

How did you find Rub Music Enterprises, the shell company you merged with?One of the third-party investors we were working with had done deals like this in the past and was aware of this particular company.

Is one shell better than another? Or do you just need a warm body?The key factor with a shell is how clean it is. Once you merge with it, you're taking on any liabilities. You want a company that ceased operations very cleanly, has been doing the SEC reporting, and knows its shareholders, so it can get all the shareholder transactions taken care of cleanly so there are no issues down the road.

The second thing is that the shell has registered, tradable securities. Under SEC Rule 144, unregistered shares don't become tradable until a year after the merger. Rub Music had 1.5 million registered shares among its total 12.5 million shares outstanding.

Did the shell's shareholders get any money, or just stock in the new company?Primarily stock. There was a slight buyback, of $180,000, primarily to reimburse the SEC reporting costs [incurred by the shell's shareholders] in the two years since the company became inactive.

A company like this obviously won't be profitable for a few years. You're prepared to hang in for that long not knowing what the outcome will be?Oh yes. The long-term potential here is great. There aren't any competitors using the shock-wave spectrum for what we're doing. There is a tremendous unmet need right now for this health-care system. And there will be a number of inflection points that will really increase the company's value. In late 2010, we'll get the data on how the first clinical study has gone. We anticipate getting our first FDA approval in 2011, and there are a lot of people who will invest in a company that has an approved product. We expect to be out in the market by the end of 2011.

Exactly what are the devices you're developing going to be used for?We're targeting four verticals: wound care, orthopedics, cosmetic, and cardiac. We're starting with wound care. Our first clinical trial is for treating diabetic foot ulcers, which by itself is a $2 billion market, out of the total $10 billion wound-care market. The FDA provides an investigational device exemption that allows you to do the study. You have to get a separate one for each indication, which is something specific — a diabetic foot ulcer, for example, not just any wound. After that we'll move on to pressure sores and then burns.

Why not start with orthopedics, since Sanuwave was born out of the orthopedics division of HealthTronics?We had two FDA approvals for a device called the OssaTron that treated plantar fasciitis and tennis elbow. It was a great technology — there was an 85% long-term cure rate with just one treatment. But there were a couple of problems with the business. One had to do with patient reimbursement. Those conditions are pain indications. If you wait long enough, it will heal itself, even if it takes two years. And knowing that, insurance companies over time pulled back on that reimbursement. The second thing was that the units were huge, 600-pound boxes, and very expensive to purchase, so we operated mobile vans that brought the devices to hospitals and surgical centers as needed.

It was not cost-effective, and we discontinued it. Now we're using the same technology for different indications, but harnessed in a small box the size of a desktop computer that weighs 20 pounds. The good thing is that we had trained 4,400 foot and ankle surgeons and podiatrists to use the OssaTron, and we'll be taking our new device for diabetic foot ulcers to those same doctors.

With a company in the stage of development yours is in, what are the CFO's day-to-day activities?You wear a number of different hats. Lately I've been working a lot on SEC reporting. But the biggest thing is continuing to raise funds to take us through the end of 2010. Part of that is presentations to retail-based investors who can buy stock today. Another part is continuing to work with larger, private investors.

Will you be issuing new stock to get more public investment?We could do that today, but under the rules the stock would not be registered for a year. People could buy the shares but couldn't sell them. So we can either wait a year or do a full S-1 filing with the SEC to register new shares, like you do with an IPO, which is what we'll probably do. It will take a few months, but there are people who are interested in investing in us, and whether they invest tomorrow or four months from now or a year from now, they're going to want the shares to be tradable. So we might as well get started on that.

What else are you involved in?Now that we're public, we need to be very cognizant of our forecasts — make sure we set realistic goals for our clinical work and product development, and then achieve those goals. In our case, that is not driven by revenue but by what we're spending. The clinical studies are expensive — the first one is running close to $4 million over a three-year time frame. We include that in our R&D costs, which total between $3.5 million and $4 million a year.

What costs have you identified that you could trim back since you went public?Well, unfortunately, there's none that we're going to take down. Over the past two years, we've spent significant effort streamlining the operation to where it's running very lean and efficient. I actually see increased costs. Being public results in accounting, filing, legal, and staffing costs.

What I'm doing with costs is more of a utilization strategy. It's looking forward and managing the resources we have according to the priorities for the four verticals we're in. Cardiac is really for the future, even though we know it has huge potential. The other three we're already working on, and as things progress, things may come up that offer quicker opportunities, so we'll go down that path and hold off on something else that needs more time and capital. It means staying on top of how things are going on the clinical side and with R&D.

Those aren't just finance decisions, are they?Oh, no. That is an all-hands strategy, working with sales and marketing, R&D, the regulatory quality people who are tied in with the FDA approval process — everybody. My role is to keep things moving along and focused and see that we're getting the return on investment that we want.